Bigger is not always better

January 18, 2016

‘Scaling up’, or growing businesses is a key activity towards reducing Ontario’s prosperity gap, which we know lags behind our US peer jurisdictions. In our Working Paper 23, A place to grow: Scaling up Ontario’s firms, we found that even with the various federal and provincial policies aimed at growing businesses, Ontario has not made progress in this area.

Why do we care about firm size?

Generally speaking, larger firms are more productive than smaller firms. Here we refer to productivity as a measure of unit of output per worker. Take for example companies like Microsoft, Amazon, and Facebook – these massive companies are able to be highly productive, more so than a small enterprise can be. So when we examine Ontario’s business landscape, and we find that most of our companies are small to medium sized enterprises, we know this topic requires some attention.

Re-defining firm size

‘Scaling up’ traditionally refers to adding more employees to the firm. Firms are considered small, medium, or large based on employee headcount, as follows:

This measure falls short of capturing the bigger picture. In today’s modern workforce, simply increasing the number of employees at a firm does not necessarily mean that an enterprise is more productive. For example, H&R Real Estate Investment Trust, which invests in office, industrial, and retail properties like Scotia Plaza and Atrium on Bay in Toronto. H&R employed only 9 workers yet generated $839 million in revenue in 2013. While this is an extreme example, it demonstrates that employing more workers is not mandatory for increasing revenue per worker.

For this reason, the Institute proposes a revised definition of firm size. The traditional firm size classification is used by federal and provincial governments to determine everything from tax deductions and grant allocations. Yet these categories do not take into account the reality that a ‘small firm’ can be more productive (in terms of revenue per worker) than a ‘large firm’.

To correct this problem, we measure firm size differently in our Working Paper, according to revenue per worker (a proxy for productivity). Doing so shifts the focus of scaling up firms from simply hiring employees to improving productivity.

How can Ontario improve its productivity?

Unsurprisingly, given the diverse nature of Ontario’s businesses, there is no “one size fits all” solution for scaling up firms.

In Working Paper 23, we examine firm level data to determine which variables help firms scale up, sector by sector. By targeting firms that make the best use of government’s programs, policy makers can get the biggest bang-for-their-buck. For example, employing more people in a manufacturing firm does not significantly increase revenue per worker, but taking on a moderate level of risk does. Further, retail firms located near similar businesses generate more revenue per worker, but importing and exporting has a negative effect.

Programs should not neglect the service sector

The Institute was inspired to continue the work done by Don Drummond which compiled a list of provincial programs designed for businesses. By our count, the government of Ontario directly or indirectly funds 127 initiatives. But these initiatives are not strategic. They do not target factors that increase revenue per employee, and do not focus on sectors that are likely to grow. Further, the sheer number of programs and their lack of organization wastes businesses’ resources and discourages an entrepreneurial culture.

Programs also neglect the service sector. Ontario’s service sector produces 77 percent of GDP but are only targeted by 17 percent of initiatives. At the same time, declining sectors are receiving protectionist supports, while those with potential for growth are being neglected. This trend needs to be reversed.

A sortable list of the 127 programs and their details are available here.

How to read our Working Paper

The Working Paper is broken into short and long versions. The short version is concise and digestible. The results are laid out sector by sector with the direction that variables influence firm size, but not the magnitude. The reader can quickly determine the factors that, on average, have the greatest impact on improving their firm’s size (according to their sector).

The long version offers a more holistic view of the 7 sectors analyzed in the Working Paper. It delves deeper into the effect that each variable has on firms. Precise coefficients are presented instead of only the direction of the effect. A novel approach is also applied in order to determine the effect each variable has not only on average but at all firm sizes. This method reveals the firm sizes that react most strongly to each variable - providing guidance on where policy instruments might be most effective.